Although my term life insurance policies are level premium policies (same premium due every year of the term) there are advantages to a non-level premium policy. An annually renewable term (ART) policy is one where the premium goes up each year of the policy. Although that makes later years very expensive compared to the first few years, it offers an advantage in that you have more money available early in your career to pay off loans and invest. For super savers, it also gives you the opportunity to drop the policy when you reach financial independence, potentially saving a large percentage of the total premiums you would pay by purchasing and then cancelling a level premium policy early. However, some agents are skeptical that ART is actually less expensive than a level premium policy, so I thought it would be useful to run the numbers.
Daniel Wrenne, a financial planner and advertiser on the site, provided me an annually renewable term policy from AXA, which was the least expensive one he could find. We ran the numbers using a healthy, non-smoking 30 year old male in Kentucky and a $1 Million policy. Now, bear in mind that while the company cannot cancel your policy on you, they can increase the premiums by more than the schedule shows. So you have to look at both the projected premiums and the guaranteed premiums. The good news is that, reportedly, AXA has only increased premiums above the schedule one time in the past. We will compare to the least expensive level 10, level 20, and level 30 policies I could find.
|Year||ART Sched.||Total||ART Guar.||Total||Level 10||Total||Level 20||Total||Level 30||Total|
Sorry the table isn't prettier.
Now, while you're enjoying number overload, let's try breaking this down. The first column is the year of the policy, it goes from 1 to 30. The next column is the scheduled column for an ART policy, with the third column being the total premiums paid to that point in the policy. You can compare this to the next two columns, for the guaranteed premiums in the policy. As you can clearly see, nothing is keeping the insurance company from raising the premiums through the roof right away. No guarantee there. That's the first downside of using an ART policy.
But, if for some crazy reason they raise the rates dramatically (and they have to do it for everyone in your insured class, not just you), as long as you're insurable, no big deal. You just go buy another policy from another company. Combine that with the fact that raising rates significantly is very unlikely, and I feel pretty good just using the scheduled premiums for the rest of our comparisons. If you want the guarantee, get a level premium policy.
ART vs 10 Year Level
Now, let's compare ART to a ten year policy. As you can see, the ART has higher rates than the ten year policy starting in year 1. So if you really only want a policy for a few years (i.e. 10 or less) there's no sense in buying an ART policy. Just go get a 10 year level premium. It doesn't make sense, but that's apparently the way it is.
ART vs 20 Year
Next, we'll compare ART to a twenty year policy. As you can see, the ART has higher rates starting in year 11. However, the cumulative premiums paid become equal in year 17. By year 20, you will have paid an extra $1,095 for the ART policy.
ART vs 30 Year
Now for the 30 year, which is what most people would recommend for a 30 year old. The ART rates become higher than the level rates in year 19. The cumulative total for the ART doesn't become higher until year 28, and even if you keep it a full 30 years, you're only going to pay an extra $2,385.
Bottom line for this particular person seeking insurance: if you're going to cancel your policy in 17 years or less, better to buy an ART than a level 20 policy. If you're going to cancel in 28 years or less, better to buy an ART than a level 30 policy.
The Time Value of Money
But wait, there's more. We haven't taken into consideration the time value of money. Money in year 28 simply isn't worth as much as money in year 1. If we assume this particular person actually invested the difference, and earned 5% on it, how much better off would he be than if he had bought the level premium policy?
Comparing the ART to the 20 year policy, after 10 years when the premiums for the ART policy finally become larger than the level policy, the ART dude has an extra $1633 sitting around to help pay them. This has the basic effect of pushing the break-even point out from year 17 to year 19.
It gets even better when comparing with the 30 year policy. After 17 years when the ART premiums become larger, ART dude has over $14K sitting around. In fact, after 30 years, assuming all that money saved was earning 5% the whole time, he still has an extra $6K for his efforts.
I find that result kind of exciting. I see annually renewable term as more of a “pure” insurance than a level premium policy. You use it until you hit financial independence, then you cancel it. What it costs you is what it costs you. While some people might be pushed to cancel their policy earlier than they should due to the rapidly climbing premiums, others will use that escalating premium to motivate them to save more, trim expenses more and invest smarter. I don't necessarily see behavioral issues (because personal finance is both finance-i.e. math and personal- i.e. behavior) working better for either policy. You do lose the guaranteed premiums. But as we've seen time and time again with various insurance products, guarantees aren't free and they rarely come cheap. Only transfer the risk you absolutely need to and, with discipline, you're likely to come out ahead financially.
Your Mileage May Vary
So what should you do? Well, I suggest that if you want to consider this non-conventional approach that you make a table such as the one above using the actual policies a good independent life insurance agent generates for you. Project when you expect to be financially independent. Then compare the ART policy to a level term policy of appropriate length. I won't be buying an ART because I already own level premium policies bought years ago and will reach financial independence in less than 1 years. But I kind of wish I had at least considered them when I purchased my policies. I might have chosen not to pay for the guarantees of a level premium policy.
What do you think? Do you own an ART policy? Why or why not? Did you consider one? If you are an insurance agent or financial planner, what would it take for you to recommend one to your client? Comment below!